Stress Test

  The second reason was that there were better candidates out there.

  “Like who?” the senator asked.

  Bob Rubin and Larry Summers would be better, I replied. They both had already done the job extremely well. If Senator Obama went to the White House at this scary time—and the polls suggested he would—he’d want the best people around him.

  My third reason was that in a period of turmoil and uncertainty, the public would want to see a familiar and reassuring face in charge of the country’s finances. I had spent my career in obscurity, and I didn’t think of myself as a reassuring presence. I looked young. I had never appeared on TV.

  Number four was that at some point, we would solve the financial crisis, and the new president would be left with a slew of other challenges—health care, tax reform, the country’s long-term fiscal mess—that had not been my life’s work. I suggested that Senator Obama should look for someone with a broader range of experience, not just a crisis manager like me.

  I thought the last reason was the one that made me a nonstarter: I had been deeply involved in the crisis response from day one. I was another Mr. Bailout, a political albatross, a vestige of the bad old days before Senator Obama arrived with his hope and change. Hiring me would look like an endorsement of all the unpopular stuff Hank and Ben and I had done.

  “I’ve been up to my neck in this crisis,” I said. “You’re going to have a hard time separating from these choices if you ask me to work with you.”

  Senator Obama suggested he wasn’t concerned about political appearances, but I said I wouldn’t just be politically problematic. I believed in the merits of all that unpopular stuff that I had been part of.

  “I’m proud of what we’ve done,” I said. “I’m not going to renounce it or criticize it. And that would make it harder for you to chart a different course.”

  I liked him, and he seemed to enjoy the meeting, too. David Axelrod, his top political aide, would later joke that the senator and I had an instant “bromance.” According to Axelrod, Senator Obama immediately informed his team that I would fit in perfectly; he supposedly told anyone who would listen that I had tried to talk him out of hiring me. The campaign was overwhelmed with jobseekers explaining why they would be perfect in Washington, so I guess my arguments against had a perverse effect.

  It was not my intended effect. My reservations were real. And Carole didn’t just have reservations; she was opposed. I felt guilty that I was even thinking about relocating again. I had also promised Carole that we would never again live apart, not for anything, and I knew we couldn’t move the kids in the middle of the school year. I remember talking through my anxieties with my close friend and former Treasury colleague Josh Steiner, who was helping to run a team working on economic policy ideas for Obama. He listened patiently, then said: “Yeah, but if the president decides you’re the best person for the job, are you prepared to say no?”

  “Well, he’s not going to decide that,” I replied.

  Over the next couple weeks, I thought about it more. Josh had a point. I did believe citizens have a certain obligation to serve their country if their president asks them to. And I definitely got caught up in the honor and excitement of it all. Obama seemed serious about policy and great at politics. I supported his general call for change, as well as his specific agenda of health care reform, public investments in research and infrastructure, and a more progressive tax code. With the passage of TARP, the main focus of the crisis response had shifted from the Fed to Treasury, and I did think my experience would be helpful to a new president inheriting a financial war. I worried about my weaknesses, but I persuaded myself that as long as I made sure Obama and his team understood them, really understood them, they weren’t a good excuse to say no.

  On Election Night, I watched the returns at home with my family. We were all ecstatic when Obama was announced the winner and gave his inspiring speech in Grant Park. I wish I could say Carole was so ecstatic that she urged me to follow the President-elect to Washington. She didn’t. She hadn’t wavered. She already thought I was too absent, too stressed out, sacrificing too much family life. She felt sick about the whole idea.

  But I knew I wouldn’t be able to say no if President-elect Obama asked.

  FORTUNATELY, I had my job at the New York Fed to distract me from the speculation about my next job. Unfortunately, one of my main distractions was AIG, which was still hemorrhaging cash. It was about to announce a devastating $24 billion third-quarter loss. The financial crisis was a tough time to be any financial firm, but it was an impossible time to be a financial firm that provided insurance against the failure of other financial firms and financial instruments. As those firms and instruments lost value, AIG was getting crushed by incessant margin calls, prompting rating agencies to consider new downgrades, which would lead to additional margin calls. The company was once again on the brink of default itself, even after our twelve-figure assistance package.

  Default was not an option, not unless we wanted a global stampede that could have made the aftermath of Lehman look relatively mild. But we didn’t want to keep throwing money into a bottomless pit. AIG was starting to look like our Vietnam. We spent much of the week of the election trying to design a more lasting rescue plan that would stop the margin spirals and stabilize the company.

  We decided Treasury would inject $40 billion in new capital through TARP, while the Fed would restructure our $112.8 billion in earlier support to AIG by creating two complex new Maiden Lane vehicles, similar to the structure used for Bear. We then transferred the mortgage-related paper that was prompting the margin calls into those vehicles. The idea was to help AIG continue to meet its obligations, while roping off the distressed assets that had propelled the company into a doom loop. We hoped this would be a tourniquet to stop the bleeding, rather than another mere transfusion of cash that would need to be followed up by still more transfusions.

  The numbers were so large that we decided it was at least worth exploring whether AIG’s counterparties would accept voluntary haircuts on their claims. A few cents on the dollar in concessions could have saved taxpayers perhaps $1 billion. But seven of the eight top counterparties flatly rejected anything less than 100 cents on the dollar. We could not force them to accept haircuts without forcing AIG into default. And we couldn’t credibly threaten default to try to induce them to accept haircuts voluntarily. We were committing more than $150 billion to AIG to try to avoid a catastrophic default; the counterparties knew we wouldn’t jeopardize the entire rescue, not to mention the stability of the global financial system, in a long-shot effort to shave a billion off the total. And even threatening default could have prompted the rating agencies to downgrade AIG, which would have required us to inject even more cash to keep it afloat. So the counterparties were all paid at par.

  I thought our no-haircuts strategy was a no-brainer. The whole goal of our interventions was to calm the system. As we had seen with WaMu, which was less than one-third the size of AIG and much less vital to the broader financial system, haircuts send a destabilizing signal that more haircuts are coming, encouraging runs on financial firms. And if the federal government had invalidated AIG’s contracts—or abused our regulatory power by muscling its counterparties into “voluntary” concessions—we would have sent a signal that no contracts were safe, even after the U.S. government and the Federal Reserve had gone to extraordinary lengths to save a systemic institution. We also would have dramatically weakened the power of the Columbus Day capital injections and guarantees. And we would have undermined the power of any future emergency assistance.

  Nevertheless, our failure to impose haircuts on AIG’s counterparties would become Exhibit A for the populist outrage and critique of our crisis response, grist for noisy congressional hearings and moralistic oversight reports. Our critics didn’t explain how we could have imposed haircuts—many counterparties weren’t even U.S. firms—or why haircuts (or even protracted negotiations over haircuts) wouldn’
t have produced downgrade and default. They simply found it obscene that our payouts to AIG flowed straight to financial giants such as Goldman Sachs. They didn’t have better solutions; they just didn’t like ours. We were often vulnerable to that kind of attack, because we rarely had good options. We just tried to choose the least-bad ones.

  Goldman Sachs was a particular lightning rod, because Hank and the chairman of my board, Steve Friedman, had both run Goldman, while one of Hank’s top aides on AIG issues, Dan Jester, and my markets chief, Bill Dudley, were former Goldman executives. It has become an article of faith in some circles on the left and right that the AIG rescue was obviously a backdoor bailout for Goldman. But it wasn’t. The post-crisis investigations documented that Goldman’s exposure to AIG through the trades in question was basically flat. AIG at one point owed Goldman about $14 billion, so the rescue looked like a windfall, but that was mainly part of Goldman’s “matched book,” where every dollar of insurance it bought from AIG was matched by a dollar it sold to another firm. So the $14 billion simply passed through Goldman to those other firms. And even if we hadn’t stood behind AIG’s side of the bargain, Goldman had protected itself against AIG’s failure, too.

  It’s true that some of the firms from which Goldman had purchased that protection, such as Citi, had their own vulnerabilities, and might have struggled to honor their contracts if AIG had defaulted. In that sense, Goldman did benefit from our rescue, as did every bank and investment bank in the world. Default by AIG would have dramatically intensified the pressure on the entire system, bringing us back to the edge of financial Armageddon. And the acute pressures of the financial crisis were already damaging the Main Street economy. In that regard, everyone benefited from our decision to prevent AIG’s failure, not just the millions of families and businesses around the world with AIG policies, but everyone with a job, a house, or some savings to lose. That’s why we did what we did.

  IN EARLY November, just before we announced the latest aid to AIG, I flew to Chicago to meet with President-elect Obama. The media were reporting that he was likely to choose either Larry Summers or me as his Treasury secretary. I usually made a point of not reading about myself in the news, but I did see some of the press I was getting during the cabinet speculation. I remember telling my family not to read any of it, because if they believed the good stuff, they might be more inclined to believe the bad stuff, and there would surely be bad stuff.

  I had no idea.

  In the airport lounge at O’Hare, I ran into Larry, who was, I’m pretty sure, in the process of checking the Intrade odds on Obama’s choice for Treasury. It was kind of awkward for both of us. Larry helped launch my career at Treasury, catapulting me from noisy scribe to a series of increasingly senior positions. He had helped get me the New York Fed job, too. We were friends; we played tennis every spring with some former Treasury colleagues at the Bollettieri academy in Florida. We had not always agreed on policy; we had fought about all sorts of things when he was my boss, and we had privately argued about much of my work during the current crisis. But now we were both candidates for a job that Larry had already done with distinction, at a time when he was eager to return to the public sphere. At the airport, I told Larry I had not sought the job and had urged Obama to choose him as secretary, which didn’t really make the situation less awkward.

  Obama met with Larry first, then me. The President-elect looked less relaxed than he had looked three weeks earlier in New York. He asked tougher questions, too. I remember thinking: Hey, I tried to talk you out of this. Why are you pushing me to talk you into this? At one point, he told me Rubin had said I wasn’t very articulate, and asked me to respond.

  “It’s true,” I said. “And it’s worse than you think.”

  He also asked what I would do about housing. Three-quarters of a million homes had entered the foreclosure process in the third quarter, and with more homeowners starting to lose their jobs, delinquencies were rising fast. Fannie Mae had just announced a startling $29 billion third-quarter loss. There was intense political pressure for the government to match its largesse for banks with some largesse for ordinary homeowners. But that hadn’t been my focus at the Fed.

  “I don’t know what I would do,” I said. “But I’m sure we can do more than we’re doing now.”

  The President-elect also asked me what I thought of Larry. I told him about Henry Kissinger’s famous line that Larry should have a permanent White House office in charge of knocking down dumb ideas—a line that had first become public after I told it to a reporter years earlier. It’s no secret that Larry is brilliant, but until you’ve been carved up by his intellectual scalpel, it’s hard to grasp just how brilliant. There is no one better at exposing the flaws in an argument. I tried to convey to the President-elect that Larry was a uniquely compelling talent.

  I returned to the airport after the interview. When I was in the security line, I got a call from Rahm Emanuel, the President-elect’s new chief of staff. He wanted to know if I’d accept Treasury if offered, but also if I’d be willing to run the National Economic Council if I wasn’t named Treasury secretary. I said I’d be willing to do Treasury, but not the NEC. The NEC director is usually the president’s chief economic adviser, with an opportunity to influence an even broader array of issues than the Treasury secretary. But it is more about framing and coordinating policy than making or executing decisions. I didn’t think it would make sense to abandon my New York Fed colleagues during the crisis to take a role like that. At Treasury, I would be more directly responsible for finishing what we had started, and then trying to fix the broken financial system.

  A week later the President-elect called to ask if I’d be willing to work with Larry if he ran the NEC. I immediately said I would, even though I knew it would mean more awkwardness. Some of our former colleagues thought the idea of Larry at the NEC bordered on lunacy. It was hard to imagine a former Treasury secretary in an advisory role. And the NEC director is supposed to be an honest broker, making sure the president is exposed to diverse views, while Larry wasn’t known for sublimating his own views. But he was the smartest economist I knew. And I thought Larry’s imperious reputation was overstated; he’s evidence-based, and he enjoys being challenged. In any case, I knew that if I became Treasury secretary, I’d be calling Larry no matter what he was doing. I valued his advice, and we would need all the talent we could get.

  A few days later, while I was in the car heading home from work, the President-elect called to ask me to be his Treasury secretary. Hank had told me that when President Bush offered him the job, he had a list of carefully considered conditions, and had even given me his list as a model. I told the President-elect I didn’t have any conditions. But I did have two things I cared about.

  “One is that I want to make sure you know what you’re getting with me,” I said.

  This was just reinforcement of our initial meeting in New York. I wanted to marinate him once more in my downsides: my lack of gray hair and gravitas, my lack of economic policy experience beyond financial and international issues, and most of all my unwillingness to distance myself from our financial rescue strategy. The President-elect said he understood all that.

  “The second thing is I want to make sure you want a strong Treasury,” I said.

  I wasn’t that worried about getting micromanaged, partly because I had a good feeling about my relationship with Obama, partly because I knew that after living the crisis I’d have a big knowledge advantage over my new colleagues. Still, I wanted to make sure that I wouldn’t be expected to dance to the inclinations of the West Wing staff, although of course I didn’t put it that way. The President-elect was very reassuring about my role, and he would more than keep his word.

  We had guests at the house that night, so I couldn’t tell Carole the news right away when I walked in the door. But she saw it in my eyes. I could tell she wasn’t happy. I was ambivalent, too. My dread about the economy—as well as my guilt about what I was doing to
my family—was stronger than my pride and excitement.

  My impending nomination was leaked to the press at 3 p.m. on Friday, November 21, and the stock market promptly jumped 6.5 percent in the last hour of trading. It was tempting to see that as a flattering vote of confidence that the new president would succeed in preventing a second Great Depression, but I knew that praise from markets could be fleeting, and was not always evidence of good policy. Some simply viewed my appointment as a signal that we were likely to continue to provide government assistance to the financial system. As a matter of fact, when I got the call from Chicago, we were in the midst of engineering yet another rescue.

  THIS TIME, the domino in danger was Citigroup, a behemoth three times the size of Lehman Brothers and far more integral to the functioning of global markets.

  Citi was still a mess, choking on mortgages on and off its balance sheet, with a highly vulnerable funding base compared to other major U.S. banks. Its stock price briefly rebounded after its TARP capital injection, but the glow wore off quickly as its losses kept mounting. Its problems intensified on November 12, when Hank announced that the Bush Treasury would not be purchasing any illiquid assets after all. I agreed with Hank’s decision, but the announcement seemed unnecessary, sucking hope out of the markets at a fragile time, pushing down asset prices and hurting confidence in financial firms at a moment when Citi looked like the weakest link. A week later, the off-balance-sheet SIVs that got Citi in trouble in the fall of 2007 faced such daunting losses that the company had to bring the rest of them back onto its balance sheet, spooking the markets yet again. Its stock price dropped below $4, down 93 percent from its 2006 peak.

  Hank told me he felt responsible, but I told him this wasn’t on him. There was plenty of blame to go around, some of it mine. Citi’s many regulators, including the New York Fed, had failed to save Citi from itself during the boom. We had recognized its vulnerabilities too late. What mattered now was making sure it didn’t implode and crater the financial system.